Credit Markets Rejoice on Fed Signal Low Rates Will Last Longer

(Bloomberg) -- Credit markets are getting a second wind, thanks to a Federal Reserve that’s suddenly not as confident the economy is strong enough to weather a steady rise in interest rates.

Policy makers said on Wednesday they now expect the federal funds rate to end the year at 0.625 %, down from their 1.125 % forecast in December. The outlook for next year dropped to 1.875 % from 2.5 %. Bonds soared, with the yield on the 10-year Treasury note, a benchmark for everything from corporate debt to mortgages, plunging below 2 % in its biggest decline in more than two months.

“The party is still on,” said Timothy Doubek, who helps manage $26 billion in company bonds as senior portfolio manager at Columbia Management Advisers in Minneapolis. “Credit markets are catching a wind because of the Fed, which will keep companies coming to market.”

After starting the year strong, corporate bond returns have wilted since the end of the January, with the Bank of America Merrill Lynch U.S. Corporate and High Yield Index losing 0.42 % through Tuesday. Prospects that the Fed may not be as aggressive as anticipated in raising rates may encourage investors to step back into the market.

RISING TIDE’

That’s good news for corporate borrowers, who issued an unprecedented $1.65 trillion in bonds last year in the U.S. at record low rates, according to data compiled by Bloomberg. Despite a recent fall off, sales this year are already up 12 % over the same period of 2014 to $437.9 billion

“Lower interest rates are a rising tide that continues to lift all bond boats, encouraging a flight to higher-yielding assets, including corporates,” said Guy LeBas, chief fixed- income strategist at Janney Montgomery Scott in Philadelphia, which manages $61 billion in assets.

The Fed has held benchmark rates near zero since 2008 to boost growth, fueling demand for relatively higher-yielding corporate debt. Average yields on U.S. corporate bonds at 3.76 % are below the five-year average of 4.25 %, according to Bank of America Merrill Lynch Index data.

“Long-term low rates continue to make it pretty cheap for companies to finance,” LeBas said.

LOWERED OUTLOOK

Fed Chair Janet Yellen lowered her outlook for growth on Wednesday, saying she will need to see more improvement in the labor market and be “reasonably confident” that inflation is picking up before raising rates. She said policy makers’ decision to remove the word “patient” from their statement “doesn’t mean we are going to be impatient.”

After the Fed announcement the risk premium on the Markit CDX North American High Yield Index, a credit-default swaps benchmark tied to the debt of 100 speculative-grade companies, slid 14 basis points to 311.9 basis points, pushing the gauge back toward the lowest level this year. A basis point is 0.01 percentage point.

While Yellen’s policy shift is fueling demand for company bonds, the debt is increasingly vulnerable to losses when rates do ultimately rise. Duration, which tracks the sensitivity of bond prices to interest-change changes, is the highest on record for company securities, Bank of America Merrill Lynch index data show.

SHARPER’ TIGHTENING

The “pace of tightening might be a lot sharper than people are expecting,” said Gershon Distenfeld, director of high yield at AllianceBernstein. “At some point, economic growth might force their hand to move faster than people are thinking.”

Anthony Valeri of LPL Financial believes that the Fed is not rushing to raise borrowing costs. On Wednesday, money- market futures traders cut the odds of a rate increase below 50 % until December. They also lowered their bets for how high the fed funds rate will climb next year.

“This Fed meeting implies a lower for longer scenario,” said Valeri, a market strategist with LPL Financial in San Diego. The move “facilitates more corporate debt issuance.”